Post on 25-Sep-2020
1
STATE INVESTMENT COUNCIL MEETING
Asset Allocation Discussion
July 22, 2020
Agenda Item 5
2
Capital Market Assumptions
Source: Aon, Aksia TorreyCove, Cliffwater, Division of Investment, Hamilton Lane, and Horizon
Compound
ReturnVol
Compound
ReturnVol 1 2 3 4 5 6 7 8 9 10 11 12
1 U.S. Equity 6.14% 15.19% 6.12% 17.90% 1.00
2 Non-U.S. Developed Market Equity 6.83% 16.95% 6.71% 20.00% 0.78 1.00
3 Emerging Market Equity 7.77% 21.34% 7.64% 27.00% 0.72 0.75 1.00
4 Private Equity 9.40% 21.50% 9.00% 20.50% 0.70 0.73 0.70 1.00
5 Real Assets 8.05% 19.40% 7.90% 17.70% 0.55 0.63 0.58 0.50 1.00
6 Real Estate 8.60% 14.57% 7.61% 12.54% 0.30 0.27 0.18 0.55 0.54 1.00
7 High Yield 5.64% 8.11% 4.69% 12.00% 0.62 0.59 0.65 0.67 0.54 0.11 1.00
8 Private Credit 7.22% 8.99% 7.60% 8.35% 0.74 0.65 0.66 0.83 0.42 0.68 0.89 1.00
9 Investment Grade Credit 2.46% 6.54% 4.10% 5.60% 0.08 0.07 0.08 0.18 0.29 -0.07 0.37 0.49 1.00
10 Cash Equivalents 0.50% 0.00% 2.80% 0.00% 0.09 0.05 0.07 0.04 0.02 0.25 0.14 -0.11 0.50 1.00
11 U.S. Treasuries 1.81% 5.13% 2.61% 3.90% -0.06 -0.05 -0.05 -0.51 -0.15 -0.13 0.05 -0.16 0.83 0.61 1.00
12 Risk Mitigation Strategies 3.34% 3.46% 4.61% 3.68% 0.49 0.49 0.49 0.22 0.17 0.26 0.30 0.34 0.27 0.11 -0.15 1.00
FY21 FY20 Correlation Matrix Recommendation
3
Risk versus Return by Asset Class and Strategy
Source: Aon, Aksia TorreyCove, Cliffwater, Division of Investment, Hamilton Lane, and Horizon
U.S. Equity
Non-U.S. DM Equity
Emerging Market Equity
Private Equity
Real Assets Real Estate
High Yield
Private Credit
Investment Grade Credit
Cash Equivalents
U.S. Treasuries
Risk Mitigation Strategies
0%
2%
4%
6%
8%
10%
12%
0% 5% 10% 15% 20% 25%
Retu
rn
Risk
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
1973 1978 1983 1988 1993 1998 2003 2008 2013 2018
Blo
om
be
rg B
arc
lays U
.S.
Tre
asu
ry In
de
x Y
ield
(%
)
U.S. Equity Non-U.S. DM Equity EM Equity Private Equity
Real Assets Real Estate High Yield Private Credit
IG Credit Cash U.S. Treasuries RMS
100%
75%
25%28%
13%
7%12%
3%
8%
2%
6%
10%
5%
5%3%
Asset Allocation With Expectations for Lower Investment Returns
4
Source: Aon, Bloomberg, and Division of Investment
In 1995, Treasuries yielded 7.8%
with a historical volatility of 8.3%.
Expected Returns Are Lower and Investment Portfolios Are More Complex
Historical Yields for Bonds
1995 – All Bond Portfolio 2020 – Stock and Bond Portfolio 2020 – Well Diversified Portfolio
Expected Return: 7.8%
Expected Vol: 8.3%
Expected Return: 5.3%
Expected Vol: 11.4%
Expected Return: 6.5%
Expected Vol: 10.8%
In 1995, an all-bond portfolio could
have been structured to earn an
attractive return for a pension plan.
Today, a portfolio comprised largely
of stocks is expected to fall short of
most plans’ actuarial assumptions.
A well diversified portfolio is
better positioned for higher
returns with less risk.
An important trade-off,
however, is less liquidity for
some of the highest yielding
asset classes.
Today, the average yield
for Treasuries is 0.5%.
1%
2%
3%
4%
5%
6%
7%
8%
2% 4% 6% 8% 10% 12% 14% 16%
Exp
ecte
d L
on
g-T
erm
Retu
rn
Expected Risk (Volatility)
The NJ Pension Fund Seeks To Earn the Highest Return Per Unit of Risk
5
The NJ Pension Fund’s well-diversified
structure is designed to earn an
attractive risk-adjusted return.
The Investment Frontier
Source: Division of Investment
Return Per Unit of Risk
Less
Diversification
More
DiversificationLess
Diversification
More
Diversification
Bonds in 1995
Current NJ Portfolio
Stocks and Bonds
Diversified Portfolio
0% 10% 20% 30% 40% 50% 60% 70% Current Targeted
Asset Allocation
80% 90% 100%
Expected Long-Term Return 2.06% 2.70% 3.32% 3.92% 4.51% 5.08% 5.63% 6.16% 6.52% 6.68% 7.18% 7.66%
Expected Risk 3.92% 3.26% 4.12% 5.28% 6.58% 7.96% 9.38% 10.83% 11.78% 12.29% 13.77% 15.25%
Return Per Unit of Risk 0.53 0.83 0.81 0.74 0.69 0.64 0.60 0.57 0.55 0.54 0.52 0.50
Expected Long-Term Return 1.81% 2.35% 2.87% 3.36% 3.83% 4.27% 4.69% 5.09% 5.35% 5.46% 5.81% 6.14%
Expected Risk 5.13% 4.77% 4.96% 5.63% 6.64% 7.87% 9.22% 10.65% 11.69% 12.13% 13.65% 15.19%
Return Per Unit of Risk 0.35 0.49 0.58 0.60 0.58 0.54 0.51 0.48 0.46 0.45 0.43 0.40
Allocation to Return Seeking Investments
Well Diversified
Portfolio
Stocks and Bonds
6 6
Lessons From the Asset-Liability Study Still Apply
Source: Aon
30 year Economic Cost (in $ billions)
30 year Ending Funded Ratio (MVA / AL)
Base
Case
Downside
Risk
Base
Case
Downside
Risk
0% Return-Seeking $170.6 $183.2 45% 28%
10% Return-Seeking $166.2 $180.5 49% 30%
20% Return-Seeking $161.4 $179.0 54% 31%
30% Return-Seeking $156.4 $178.2 61% 32%
40% Return-Seeking $151.4 $178.0 68% 32%
50% Return-Seeking $146.2 $178.3 75% 32%
60% Return-Seeking $140.7 $179.0 82% 32%
70% Return-Seeking $135.7 $179.7 89% 31%
Current Targeted Asset Allocation $132.9 $180.2 93% 30%
80% Return-Seeking $130.8 $180.8 97% 29%
90% Return-Seeking $126.2 $182.0 104% 28%
100% Return-Seeking $121.9 $183.3 112% 27%
Present Value of Fund Contributions
Present Value of Terminal Funding
ECONOMIC COSTS OF PENSION FUND
7 7
Home Country Bias within the Global Equity Allocation Has Benefited the Pension Fund
Source: Bloomberg
Global Public Equity Returns
March 9, 2009 – February 19, 2020
18.38
10.55 11.07 10.4011.22
23.86
0.0
5.0
10.0
15.0
20.0
25.0
30.0
MSCI USAIMI
MSCI EAFE& Canada
MSCI EAFE& Canada
MSCIEmergingMarkets
MSCIEmergingMarkets
MSCI USATechnology
Tota
l R
etu
rn (
%)
(US $)(local
currency) (US $)(local
currency)
59.6% 58.3% 55.0%44.0%
26.6% 30.3% 33.1%
43.0%
13.8% 11.5% 11.9% 13.0%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
USA Non-US DM Emerging Markets
8
Global Equity Allocation
Source: Division of Investment and MSCI
NJ Global Equity Allocation vs ACWI
NJ Targeted
Asset Allocation
ACWI
Now One Year Ago Ten Years Ago
9
The COVID Pandemic Has Halted the Global Economy
Source: International Monetary Fund
3.602.90
1.90
4.50
6.70
2.902.30
1.30
3.70
6.10
-4.90
-8.00
-10.20
-3.00
1.00
5.404.50
6.00 5.90
8.20
-12.0
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
World US Euro Area EM China
GD
P G
row
th (
%)
2018 2019 2020E 2021E
10
Global Equity Market Valuations
Source: Factset
U.S. Equity Valuations
6
8
10
12
14
16
18
20
22
24
26
2000 2004 2008 2012 2016 2020
Price /
Earn
ing
s M
ultip
le (
X)
S&P 500 12M Forward PE Ratio Average
6
8
10
12
14
16
18
20
22
24
26
2000 2004 2008 2012 2016 2020
Price /
Earn
ing
s M
ultip
le (X
)
MSCI EAFE 12M Forward PE Ratio Average
6
8
10
12
14
16
18
20
22
24
26
2000 2004 2008 2012 2016 2020
Price /
Earn
ing
s M
ultip
le (
X)
MSCI EM 12M Forward P/E Ratio Average
Non-U.S. DM Equity Valuations
Emerging Market Equity Valuations
-4
-2
0
2
4
6
8
10
12
14
2000 2004 2008 2012 2016 2020
Rela
tive
Price/E
arn
ing
s M
ultip
le (
X)
S&P 500 less EAFE P/E S&P 500 less EM P/E Avg Avg
Global Equity Valuation Comparisons
Higher U.S. valuations
Lower U.S. valuations
11
Private Equity versus Public Equity
Source: Cambridge and Aksia TorreyCove
Note: Private Equity returns are global and include buyout, growth equity, and venture
9.13
7.28
4.79
2.57
14.1113.42
9.03
6.39
13.27
14.25
12.54
10.53
18.68
20.33 20.28
18.33
0.0
5.0
10.0
15.0
20.0
25.0
5 Year 10 Year 15 Year 20 Year
To
tal R
etu
rn (
%)
MSCI World Russell 3000 Private Equity Private Equity Top Quartile
Returns For Periods Ending
December 31, 2019
12
There Has Been A Wide Range of Returns in Private Equity
Source: Cambridge and Aksia TorreyCove
-11% -10%
-16%
4%6%
0%
12% 12%
9%
20%19% 19%
41%
34%
48%
Small and Mid-Cap Large and Mega-Cap Growth and Venture Capital
Inte
rnal R
ate
of
Retu
rn (
IRR
) sin
ce in
cep
tion
(%
)
Bottom 5% Lower Quartile Median Upper Quartile Top 5%
Private Equity Quartile Returns By Vintage
Vintage YearMedian-Lower
Spread
Upper-Median
SpreadTotal Spread
2000 8.0% 8.9% 16.8%
2001 8.6% 11.3% 19.9%
2002 9.0% 12.0% 21.0%
2003 8.5% 8.5% 17.0%
2004 7.7% 6.7% 14.4%
2005 6.1% 5.1% 11.2%
2006 6.7% 5.8% 12.6%
2007 5.8% 5.6% 11.4%
2008 5.9% 7.7% 13.6%
2009 6.6% 7.4% 14.0%
2010 7.7% 8.8% 16.5%
2011 6.2% 6.2% 12.4%
2012 8.1% 6.2% 14.3%
2013 5.6% 6.5% 12.1%
Private Equity Quartile Returns Since Inception
13
Private Market Dry Powder and Fundamentals
Source: Aksia TorreyCove, Bloomberg, Hamilton Lane, and Pitchbook
Private Equity Dry Powder
Real Estate Cap RatesPrivate Equity Leverage and Purchase Multiples
Real Estate Dry Powder
1,047 1,042963 980
918
1,165 1,167
1,300
1,443
1,755
2,0442,156
0
500
1000
1500
2000
2500
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Dry
Pow
der
($ b
illio
ns)
Buyout Distressed PE Growth Mezzanine Other Real Estate Venture
0
50
100
150
200
250
300
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Dry
Pow
der
($b
illio
ns)
Opportunistic Value-Add Debt Core
5.0%
5.5%
6.0%
6.5%
7.0%
7.5%
8.0%
8.5%
9.0%
9.5%
10.0%
2008 2012 2016 2020
0
20
40
60
80
100
120
140
160
Cap
Rate
Ag
gre
gate
Tra
nsaction
Valu
e (
$ b
illio
ns)
Volume (RHS) Apartments Office Retail Industrial
5.1x 5.3x5.7x 5.6x 5.4x
5.7x 5.8x 5.8x
5.1x
8.7x 8.8x
9.7x10.3x 10.0x
10.6x 10.6x
11.5x 11.6x
0.0x
2.0x
4.0x
6.0x
8.0x
10.0x
12.0x
2012 2013 2014 2015 2016 2017 2018 2019 YTD2020
Debt Multiples Purchase Multiples
14
U.S. Treasury and Credit Market Valuations
Source: Bloomberg
Ten Year Nominal Yields and TIPS Breakeven Inflation
0.0
5.0
10.0
15.0
20.0
25.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
1990 1995 2000 2005 2010 2015 2020
All
in y
ield
(%
)
All
in y
ield
(%
)
IG - A or better (LHS) Avg High Yield (RHS) Avg
0
250
500
750
1,000
1,250
1,500
1,750
2,000
0
100
200
300
400
500
600
1994 1999 2004 2009 2014 2019
Op
tion
-Ad
juste
d S
pre
ad
(in
bp
s)
Op
tion
-Ad
juste
d S
pre
ad
(in
bp
s)
Investment Grade (LHS) Avg High Yield (RHS) Avg
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
1999 2003 2007 2011 2015 2019
Bre
akeve
n I
nfla
tion
Rate
(%
)
Nom
inal Y
ield
(%
)
Ten Year Nominal Treasury Yield (LHS) Ten year TIPS Breakeven Inflation (RHS)
Average Inflation
Credit Yields Are Below Historical AveragesCredit Spreads Are Above Historical Averages
Steepness of the U.S. Treasury Curve
-300
-200
-100
0
100
200
300
400
500
1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020
2 /
30 T
reasu
ry C
urv
e (
in b
ps)
2/30 Treasury Curve Average
15 15
Cross Sector Valuation Analysis
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
-6.0
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
1990 1995 2000 2005 2010 2015 2020
S&
P 5
00 E
arn
ings Y
ield
less 1
0 Y
r T
reasury
Yie
ld (
%)
S&
P 5
00
Div
ide
nd
Yie
ld le
ss 1
0 Y
r T
rea
su
ry Y
ield
(%
)
Dividend Yield Premium (LHS) Avg Dividend Yield Premium
Earnings Yield Premium (RHS) Avg Earnings Yield Premium
Stocks vs. Bonds
8.7x 8.8x9.7x
10.3x 10.0x10.6x 10.6x
11.5x12.4x
15.5x16.5x
20.8x
17.2x18.1x
15.2x
16.9x
0.0x
5.0x
10.0x
15.0x
20.0x
2012 2013 2014 2015 2016 2017 2018 2019Private Equity Russell 2000
Source: Aksia TorreyCove and Bloomberg
Private Equity vs. Public Equity
16 16
Asset Allocation Recommendation
Source: Aon, Aksia TorreyCove, Cliffwater, Division of Investment, and Hamilton Lane
Portfolio Expected Return 6.52% 6.72%
Portfolio Volatility 10.79% 11.05%
Return per unit of Risk 0.605 0.608
Current Recommended Proposed Proposed Proposed
Target Asset
Allocation
Target Asset
Allocation
Ranges Benchmarks Benchmark
Weights
GLOBAL GROWTH 59.00% 59.00%
1 U.S. Equity 28.00% 27.00% 22-32% MSCI USA IMI 28.00%
2 Non-U.S. Developed Market Equity 12.50% 13.50% 11-16% MSCI EAFE + Canada (ex-prohibited) 13.50%
3 Emerging Market Equity 6.50% 5.50% 3-8% MSCI Emerging Markets (ex-prohibited) 5.50%
4 Private Equity 12.00% 13.00% 10-16% Cambridge Associates Buyouts, Growth, Distressed for Control, Subordinated Debt and Credit (one-quarter lag) 12.00%
REAL RETURN 10.00% 11.00%
5 Real Assets 2.50% 3.00% 1-5% NCREIF ODCE (one-quarter lag) 3.00%
6 Real Estate 7.50% 8.00% 5-11% Cambridge Private Equity Energy, Upstream Energy & Royalties & Infrastructure, Timber (one-quarter lag) 7.00%
INCOME 18.00% 18.00%
7 High Yield 2.00% 2.00% 1-5% Bloomberg Barclays U.S. High Yield 2% Issuer Cap Index 2.00%
8 Private Credit 6.00% 8.00% 5-11% Bloomberg Barclays U.S. Corp High Yield Index (one-month lag) + 100 bps 7.00%
9 Investment Grade Credit 10.00% 8.00% 5-11% Bloomberg Barclays U.S. Credit Index, A or better 9.00%
DEFENSIVE 13.00% 12.00%
10 Cash Equivalents 5.00% 4.00% 3-7% 91-day T-Bills 5.00%
11 U.S. Treasuries 5.00% 5.00% 3-8% Bloomberg Barclays U.S. Treasury Index 5.00%
12 Risk Mitigation Strategies 3.00% 3.00% 1-6% 91-day T-Bills +300 bps 3.00%
Alternative Investment Program 31.00% 35.00%
Return Seeking 77.00% 80.00%
Defensive 23.00% 20.00%
Total 100.00% 100.00%